GE still relies heavily on capital unit for profit

KateLinebaugh

General Electric Co.
GE, -0.08%
may be the world's top producer of aircraft engines and medical-imaging equipment, but as far as its profits are concerned, GE is very much a bank.

Four years ago, GE promised in the depths of the financial crisis to reduce its reliance on its giant finance unit. But GE Capital is expected to account for nearly half the company's 2012 profit, far outstripping the contribution of units that produce power turbines, locomotives and oil pumps.

GE's lending arm employs more than 50,000 people, and if it were a commercial bank, it would be the country's fifth-largest by assets, according to Federal Reserve data.

The earnings split will be in the spotlight on Friday when GE reports its fourth-quarter and full-year financial results. Investors today are much less worried about GE Capital than they were four years ago. GE has managed to shrink GE Capital's portfolio of loans by more than a third, stabilize its funding base, and pass a review by the Federal Reserve.

Still, the heavy reliance on GE's lending business for profits highlights a conundrum faced by Chief Executive Jeff Immelt. His company is good at banking, but investors don't value that business as highly as they do GE's industrial units, which are struggling to post strong revenue growth.

"We are much more focused on the industrial side," said Janna Sampson, co-chief investment officer at Oakbrook Investments LLC, which owns about 3 million GE shares. "We think the Capital side is better" than compared with the crisis days.

In 2012 GE Capital is expected to contribute about 45% of the company's total earnings. That is down from 55% in 2007 but still above the target of 40% set four years ago. In December, Mr. Immelt said he plans to shrink Capital's contribution to GE's earnings to 35% by 2015 and ultimately to 30%.

GE got into lending decades ago and grew steadily, leveraging the access to cheap capital that came with the conglomerate's triple-A credit rating. Before the credit crisis, GE relied upon lending for around 50% of its earnings.

The financial crisis upended GE Capital's model. Funds that had been widely available in the short-term credit markets dried up overnight, forcing GE Capital to turn to government lending programs for help. Concerned investors sent GE's stock below $6 in March 2009. In what Mr. Immelt has called the darkest days of his tenure, GE was forced to cut its dividend for the first time in its history to preserve capital, and its sterling credit rating was downgraded by one notch to AA-plus, where it remains.

Mr. Immelt pledged in September 2008 to reduce the reliance on GE Capital. But he resisted calls to jettison the business entirely and continues to say a separation isn't practical, even though less than 5% of GE Capital's loans involve GE equipment or services.

Instead, he has focused on reducing the unit's risk. Since the crisis, Mr. Immelt has shrunk GE Capital's assets by about a third through the sales of bank stakes in Thailand, commercial property in the U.S. and leasing operations in South Korea. The finance business has refocused on its core business: loans to companies like fast-food franchises, consumer financing for such purchases as La-Z-Boy chairs, and private-label credit cards. Its reliance on short-term borrowings has fallen significantly.

GE Capital also has gradually whittled down the investments in office buildings and other commercial property that rattled investors during the crisis. Its exposure shrunk to $58 billion at the end of June from $93 billion four years earlier. And GE expects its commercial real-estate business to report a profit for 2012 for the first time since the crisis, after losing $1 billion in 2011. At one time, unrealized losses in the real-estate division were estimated at $7 billion.

Improvements in GE's industrial businesses have been slower to come. Weak global economies, concerns over the so-called fiscal cliff and slower-than-expected margin improvements weighed on some of the company's businesses in 2012. As a result, GE had to pare its forecast for 2012 growth in industrial revenue, excluding acquisitions, to 8% from the 10% level forecast just months before.

The CEO wants to improve margins at the industrial businesses by cutting $1 billion in costs and increasing the amount of lucrative service revenues from GE's industrial products. He also is pushing for sales in markets like Africa, Myanmar and the Middle East, where governments are spending on infrastructure, and is looking for acquisitions to fuel growth.

Still, this year, the company expects sluggish industrial-revenue growth excluding acquisitions of between 2% and 6% compared with 2012.

The imperative to shift the balance derives from the higher value investors place on industrial profit. Earnings from GE's finance operations are valued about 50% lower than profits from the industrial businesses, analysts and investors said. As a result, while GE's stock was up 17% last year, it still trades at a discount to other industrial conglomerates. If the company is able to significantly increase its share of industrial earnings, its share price should follow. (GE shares were recently up 1% at $21.32.)

Meanwhile, GE continues to tap its lending business for cash. GE Capital resumed paying dividends to GE last year, providing $6 billion that the company used to restart its buyback program and boost its dividend. GE Capital is expected to pay a $12 billion dividend this year. Mr. Immelt expects it to produce $20 billion of dividends for the parent over the next three years.

"The days of agonizing over Capital are clearly behind us," said Jack De Gan, chief investment officer of wealth manager Harbor Advisory Corp., which owns GE shares. "Every quarter Capital gets cleaner and cleaner and more streamlined with less and less risk of a nasty surprise."

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.